Late last week, CBRE Investors’ CBRE Capital Partners investment entity originated $61 million in first mortgage financing for the LEED Gold-hopeful Riverhouse condominium project in Battery Park City. The mortgage is backed by the 77 units that remain available at the 262-unit, 31-story building, and is for a three-year term with a one-year extension option, putting to bed some of the rumors that have been swirling for the past year about the project’s financial difficulties and poor unit sales performance. The news is also interesting because of the backdrop it provides to the fledgling Gidumal litigation, which we first reported here at GRELJ a couple of weeks ago.

In terms of the project’s somewhat sordid financial history, the Riverhouse was originally developed by Lehman Brothers and the Sheldrake Organization pursuant to a $282.4 million senior mortgage from Helaba Bank and a $74 million junior loan from the AFL-CIO trust. Although the former loan was paid off, the developers defaulted on the junior loan at maturity in November of 2009, resulting in a $48 million lis pendens filing against the property in February. Just before the filing, the Lehman entity alleged that Sheldrake had misappropriated over $12 million in funds from Helaba which had been earmarked for ground lease payments and construction expenses by submitting falsified invoices to the lender. Lehman served Sheldrake with a Notice of Removal (from its capacity as the development team’s day-to-day manager of the project), and Sheldrake unsuccessfully sought an injunction in Supreme Court barring its removal.

Afterwards, what was left of the development team hired CBRE to sell the junior note, but CBRE ultimately decided to originate the financing itself. According to Frank Scavone, COO at CBRE Capital Partners, the Riverhouse “exemplifies an otherwise successful development project in need of additional time to realize full sell out.” Affidavits submitted earlier this year in connection with Sheldrake’s application for injunctive relief indicated that 17 additional sales contracts have been signed, with another 7 out for signature – positive signs that the project is back on track.

It would be purely speculative to consider whether any of Riverhouse’s issues – at least indirectly – led to the allegations set forth in the Gidumal complaint; indeed, intra-development team power struggles are relatively common and don’t typically impact unit purchasers in any meaningful manner. However, this is the first time we’ve heard – at least publicly – these types of allegations on a green building or LEED project; whether they impacted the overall quality of Riverhouse’s construction or the performance of its building systems is the type of question mark which the Gidumal litigation could shed light on if the lawsuit proceeds through discovery.

As a final side note, the Riverhouse has yet to receive formal LEED certification; it registered with USGBC in June of 2005 under LEED for New Construction Version 2.1.

In New York (like most jurisdictions), one of the elements for obtaining a preliminary injunction is whether there will be irreparable injury to the moving party if the court denies provisional relief. However, if the court can calculate the moving party’s damages with precision, there can be no irreparable injury while the action is pending because the moving party would be adequately compensated by money damages if it were to prevail at trial. The Destiny court, however, found two exceptions to the irreparable injury test based explicitly on the project’s green features. It held that

“an exception is warranted because the Project’s unique character renders it difficult to calculate any damages sustained by Destiny Holdings. Citigroup stated through its managing director at a U.S. Green Building Council Presentation on November 8, 2007 that the Project is a ‘visionary project’ that has created a ‘new financing paradigm for green economic development’ that is ‘revolutionary.’ Citigroup Chairman and Chief Executive Officer Charles Prince called the use of newly-created Federal Green Bonds [created under the American Jobs Creation Act of 2004 and authorizing up to $2 billion in tax-exempt, private activity bonds to be issued by state or local governments for qualified green building and/or sustainable design projects] in financing the Project ‘groundbreaking [and] a step forward in addressing climate change in the U.S. because the Project incorporates sustainable design, energy conservation, and renewable energy sources on a large scale. He further commented that the Project ‘is good for economic development and good for the environment.’ Thus, the unprecedented nature and scope of the Project makes it unique, so that it has no established market value and any damages sustained could not be calculated with reasonable precision.”

The court also found a second exception to the general rule because of the project’s highly touted green features, stating that “Destiny Holdings has established the enormous potential for harm to its reputation and the reputation of the entire ‘Destiny USA’ project. Harm to business reputation is harm for which money damages are insufficient and for which injunctive relief may be appropriate.” I don’t think it’s unreasonable to infer here that the court was connecting the project’s green features to its “reputation” in order to carve out another exception to the general rule barring injunctive relief in similar contexts. For both of the foregoing reasons, the Appellate Division upheld the trial court’s decision, but modified the order granting the preliminary injunction to require Destiny to post a bond in order to compel Citigroup’s performance under the loan agreement.

Interestingly, two justices joined in filing a dissenting opinion that ignored the project’s green features. The dissent stated that “there is no support in the record for the majority’s conclusion that an ‘enormous potential’ for harm to the reputation of Destiny Holdings exists, other than the bald assertion of a principal of Destiny Holdings that its reputation would be damaged as a result of its failure to complete the project. The core of the majority’s argument is that the nature of the project makes it unique and thus that Destiny Holdings would be entitled to specific performance [of the construction loan agreement]. While the scope of the Project may be unique to the region in both its size and impact, the record clearly establishes that the [construction loan agreement] itself is simply one to loan money in order to finance construction.”

I think that there are a few important things to take from this opinion. First, notwithstanding the Destiny project’s massive scope, the Appellate Division has given owners a basis for arguing that green building projects – regardless of their financing mechanism – are inherently unique.  In the event of any type of dispute, owners or other parties which might be seeking provisional remedies or are engaged in other motion practice (that, like in Destiny, is unrelated to the project’s green design features) can now rely on appellate authority that green building projects are different and deserve different treatment under applicable law.

Conversely, the opinion suggests why construction and real estate attorneys need to be well-versed in the green building space; if you were asked to oppose a similar motion where the movant was arguing that “green buildings are different,” you would likely want to argue in opposition how, to date, many green building projects have not resulted in such different outcomes from conventional projects (i.e, by identifying the ongoing LEED performance gap and studies analyzing the alleged rental and asset premium for different types of certified green buildings).

The decision is also important to note from a lender’s perspective. If potential borrowers looking to finance a green construction project have the ability to argue that their projects deserve special treatment in connection with any lending dispute, lenders may consider, for example, revisiting the terms of their construction loans or otherwise pricing this type of risk into the loan itself.

Are there other green real estate-related legal issues arising out of this opinion that you might anticipate arising in connection with these types of construction lending disputes?

My thanks to Kevin Garrison of Baker Donelson for forwarding a copy of the Appellate Division’s opinion in this matter to my attention. Either of us would be happy to forward you a copy of the opinion upon request.

The authors used a standard commercial real estate valuation formula that related the logarithm of the rent per square foot or sales price per square foot of each building cluster to a variety of hedonic building characteristics, including quality, amenities, age, and location. Some pertinent conclusions as set forth in the report are as follows:

• “The results suggest that the LEED rating has no statistically significant effect upon commercial rents, but the Energy Star rating is associated with rents higher by 3.3 percent.”

• With respect to sales price, “[w]hen the certification is reported separately for the Energy Star and the LEED systems, there is no evidence that hte latter certification is associated with higher selling prices.”

• “The premium in rents and values associated with an energy label varies considerably across buildings. It is positively related to the intensity of the climate surrounding the rated building; a label appears to add more value when heating and cooling expenses are likely to be a larger part of total occupancy cost.”

I am extremely curious to see the reaction to the RICS study in the coming weeks. Already, several major media outlets have reported that it demonstrates “certified green buildings rent and sell at a higher price than non-certified buildings,” failing to note the study’s conclusions about the role a LEED rating may play in obtaining that higher price.

I look forward to your comments on the merits of the study once you have had the opportunity to review it; the study is available for download via the link below.

• Doing Well By Doing Good Study (RICS)

As the world financial headquarters has shifted from Wall Street to Washington, D.C., many commentators are expecting that green building will be a common condition of allocation of federally funded real estate projects whether in the form of direct subsidies or grants or public/private partnerships. This article will briefly examine a small portion of the unique legal risks that should be considered by lenders and property owners and developers in regard to obtaining financing for green buildings. It will specifically focus on ways lenders should attempt to mitigate risk through a basic understanding of green building, the careful examination of leases, construction documents and loan document covenants.

Basic Understanding of Green Building

Lenders must have a basic understanding of green building before financing green properties. They should be aware of the multiple third party green building certification systems and the specific limitations of the systems. Lenders should have teams that are familiar with the United States Green Building Council’s (“USGBC”) Leadership in Energy and Environmental Design Green Building Rating System (“LEED”) and preferably underwriters or loan officers that are either LEED Accredited Professionals (“LEED APs”) or the newly designated LEED Green Associates. If a lender does not have this level of green building experience or accreditation then they should seek outside counsel with the necessary understanding to assist them in order to minimize exposure. This level of knowledge will provide lenders with the necessary background to properly assess risks in financing green real estate.

Review of Green Leases

Leases, at a commercial property, are the most important factor in determining the value of a property. Most loan officers and underwriters are well versed in determining the property value based upon the rental stream and term of a lease. They are not as experienced in assessing the risks that may be contained within a green lease. Attorneys must assist the lender in carefully examining how the green elements of the lease could impact the value of the property. The first consideration is determining the required green elements of the lease and what happens if they are not achieved. Does the lease mandate the leased premises or property achieve a certain LEED or other third party certification status? What happens if the leased premises or the property fails to achieve said status? The lender should inquire as to the status of the LEED or other third party certification requirements, determine whether the landlord is able to satisfy its requirements and what the impact might be if landlord fails to satisfy the requirements. From a lender’s perspective, it is more palatable to see a lease provision that provides that it is the parties’ intent to achieve a certain LEED or other third party certification standard, but the failure to achieve such standard will result in some form of lease abatement or minimal free rent period instead of lease termination. Lenders are able to properly assess the value of a property with a lease abatement or free rent period, but if lease termination is available to the tenant then it is unlikely the lender will proceed with the financing, especially considering the current credit environment.

The lender should also take a more careful review in the long term property operation and management requirements within a green lease. Green building requires an active long term management plan to maintain the efficiency characteristics of the property. Certain green building classification levels may require re-certification after a certain period of time to show the property still complies with the necessary third party standards. Lenders will want to make sure that developers thus select property management companies that are able to provide the necessary services and that the property management agreement details these requirements. They may also want to review the operations and maintenance (“O & M”) plans to ensure that they are in place that are designed to comply with the green building systems in place at the property.

Finally, if the property is leased to multiple tenants then lenders should examine each lease to ensure that there are not conflicting green lease provisions that could create further challenges. For example, the lender must be able to determine the differences if one tenant requires the premises achieve LEED Silver for Commercial Interiors and another tenant requires LEED Gold for Commercial Interiors and that the property achieve LEED Silver for New Construction. These specific provisions are not in direct conflict, but if the second tenant also required that all other leases over 10,000 square feet also achieve LEED Gold for Commercial Interiors then an issue would arise if the first lease was for 15,000 square feet. A lender should also understand how the costs of the utilities may be detailed within the lease. Lenders routinely underwrite properties where all utility costs are passed on to the tenant. As some tenants are moving into green leases, in part, to have lower long term utility costs, they may have lease provisions that cap utility costs. A lender will need to determine whether the landlord is able to satisfy such lease requirements, potentially before there is even a history of performance at the property.

Construction and Building Design

Lenders that provide construction financing for green building projects should be involved in the selection of the construction team and the review and negotiation of the construction documents. The risks of green building have been detailed by commentators in this and other publications, time and time again. If a lender is willing to provide construction financing during these difficult times then they should have far more influence in the selection of qualified and experienced green building professionals then they would have in years past. Developers will hopefully work with experienced professionals in building a green project, but lenders should also examine the green building experience of the architect, contractor and subcontractors and make the approval of such professionals a condition of the financing. Lenders should review the owner-architect agreement and construction contract to make sure the responsibilities in planning and constructing the green building are clearly detailed. They will also want to make sure that there are penalties to the appropriate parties for failure to deliver the required green building. These penalties should correspond with the leases. For instance, if a lease requires a LEED Silver Commercial Interiors space and failure to provide such space will result in a two-month free rental period, the construction contract and owner-architect agreement should contain provisions that requires either a holdback or penalty in the amount of the loss of two months of rental payments to landlord, provided the failure to achieve the standard is not the fault of the property owner. The landlord may not be able to make the mortgage payments without such a provision, and the lender will obviously want to protect itself from such a possibility.

The Greening of Loan Documents

In addition to the added due diligence considerations, lenders may also need to modify loan documents in providing financing for green building projects. The first consideration will be in determining whether additional escrows are required to mitigate the risk of free rent or rental abatements in connection with certain green considerations detailed within the lease. These determinations should be relatively straightforward for the lender and again are not necessarily unique to green building. The loan documents will also provide that the landlord shall either comply or materially comply with the leases. Lenders should carefully review these provisions and may need to detail that the green building provisions are material lease provisions and failure to comply with said provisions will constitute a default under the loan, as well as the lease. Lenders may also consider adding additional covenants that acknowledge the green lease requirements and provide the specific details as to how the landlord will comply with such requirements in order to avoid any potential ambiguity.

Conclusion

Green building will continue to grow and likely become the best practice in the construction and development industry. Lenders must thus become familiar with the unique risks associate with green building. They must also be able to mitigate the risks, from the lenders perspective, when providing financing for green buildings. This article briefly examines a small sample of these issues and strongly encourages lenders to assemble a “green team” when financing green real estate developments.

Interested in contributing to GRELJ? Contact Stephen Del Percio via email here.